January 29, 2008

My take on the housing market

The homebuilding market is seeing some tough times. TOUSA filed for Chapter 11 banktruptcy today. Layoffs and shutdowns are epidemic in places like California, Las Vegas, and Florida, while homeowners suffer with rate adjustments and foreclosures.

What went wrong? Here's my take: there were two fundamental underlying reasons that this market got to this point. One's money, and the other is land.

First of all, money. The Federal Reserve has created too much money in the last nine years, by keeping interest rates artificially low. This encouraged all manner of creative financing, and got people buying houses that shouldn't have, and got investors buying houses to flip them (because financing them was so cheap.) The low rates caused demand to skyrocket, prices went up, and everybody - homebuilder, homeowner, and investor - looked to be making money. In reality, the money itself was being devalued (we see that now with the dollar dropping against foreign currencies), which was sending a confusing signal to all participants.

Why did this happen? Greenspan's Fed pumped in liquidity in late 1999 to avoid a Y2K cash and banking crunch, again in 2001 after 9/11, and then left rates low through much of the 5 years after 9/11 to keep the U.S. from experiencing anything but a "shallow" recession. It worked, and we saw some economic growth after 2001, but there is no free lunch in economics. We are paying the price for that strategy today. (And we may not be done yet.)

Secondly, we have the land issue. Demand for homes was causing the price of raw land to skyrocket. Prime lots were being taken off the market quickly, and nearly every builder was afraid of being left out of the party. After all, without land to build on, a homebuilder cannot function. So there was a mad dash by builders and speculators to acquire the best land still left.

Compounding the problem was the entitlement process, which is municipally controlled in most areas of the country, and which can have long lead times of up to five years. If you are a builder and want to build in certain cities in the next few years, you better have your land in the permit process now, because it could take a while to get it permitted, developed, and ready to build on.

What that translates to is aggressive land acquisition and development. Builders acquired, optioned, and closed on parcels, in anticipation of future demand. They had no choice, really. They risked being locked out of the market with no lot inventory on the one side, and risked getting stuck holding too much land on the other. What to do?

Once demand turned down, all those plans with built-in expectations of growth began to unravel. One thing led to another, and soon you had subprime mortgages being defaulted, land and home prices dropping, builders dumping land at 40 cents on the dollar, and others going under completely. TOUSA will try to restructure under Chapter 11, and of course we wish them the best.

I do not fault management of these builders. Most were aggressive, smart, seasoned executives with business acumen and a strong desire to compete and win. We here at Autodesk work with many of them. Sure there were mistakes made, but every business lives with those. There's no homebuilding scandal.

The media loves to lavish praise on tech companies like Google, Yahoo!, Apple, and (sometimes) Autodesk. I would ask the managers of those companies to consider the following: what if your products required a raw material that was in scarce supply, required years to make ready for production, and depended on the graces of government before you could develop on it?

And what if your products were so expensive that nearly all customers had to take out 30-year loans at a rate driven by the actions of the Federal Reserve, before they could purchase them?

Would the techs be so flexible if they had to work within those parameters?

Homebuilding is a unique business with unique constraints. Let's cut our friends in the industry some slack while they work through this tough time. Technology can make homebuilders more flexible and more ready to weather the next downturn like this (and there will be another one...eventually), but the bottom line is the ship they're in gets tossed around on the ocean called Money, and they have a massive anchor called Land, and between the two, it can be difficult to stay afloat in a big storm like what we've got now.